So given we’re all spending more time in our browsers than our trousers these days, Xinja would like to help make this time well spent, by offering a blog series – ‘making it count’ – to help boost your basic financial literacy & get money fit during iso. Today we’re looking at Stock Markets – what are the basics – and the risks – and how does it work?
Let’s start with a warning… The information in this blog does not consider your personal circumstances or constitute any personal or other professional advice and is general in nature. All investments carry risk, and you may lose some or all your money if you invest and may not be able to sell a stock at the desired price or at all. Past investment performance is not necessarily an indication of future investment performance. Take a look at the section at the bottom of this blog for some things to consider when trading shares.
What is ‘the Stock Exchange’?
According to our Head of Wealth, Alwyn Hung, this is what the Stock Exchange does: “A stock exchange allows people to buy and sell shares of ownership in various companies. It is a regulated market place allowing investors to invest in businesses via a standardised and discrete form of ownership structure and provides an avenue for businesses to attract investors and raise capital to operate their businesses. Regulation ensures maximum safety for everyone’s investments.” So essentially not that different from a vegetable or cow market, there’s just a bit more money involved. The two biggest markets in the world are the New York Stock Exhange, or NYSE and the NASDAQ (National Association of Securities Dealers Automated Quotations exchange – catchy!) The other large stock markets include the Tokyo Stock Exchange, London Stock Exchange and of course our own Australian Stock Exchange – the ASX (Sydney).
What is a ‘stock market index’?
ASX defines it as “a measure of a change in value for a group of assets.” Wikipedia has it more elaborately as “a stock index or stock market index…..measures a stock market or subset of a stock marketing that helps investors compare current price levels with past prices to calculate market performance. It is computed from the prices of selected stocks.” The US ones are Standard & Poors (S&P), Dow Jones and in London, the FTSE (Financial Times Stock Exchange or ‘Footsie’), the Nikkei is in Japan and back home we have the ASX200. The ‘selected stock’ are often the top few hundred hence ‘200’ or ‘500’ tagged on the end.
What are Shares vs Stocks vs Securities?
The technical definition of a share is: “Units of ownership interest in a corporation or financial asset that provide for an equal distribution in any profits, if any are declared, in the form of dividends.” Or, as the ASX describes it: “Part-ownership in a company”. In other words, it’s the way a public company raises capital to fund itself to operate as a business. It’s important to note here that Shareholders bear ultimate risk of a company’s performance (the value of shares can go down as well as up) but can also reap the benefits of success in the form of dividends and share performance. ‘Stocks’ and ‘shares’ as terms are fairly interchangeable although ‘shares’ is used more commonly in reference to a specific company. Stocks and shares are both ‘securities’ which are certificates or instruments which have specific financial value and can be traded (in this case ‘equity securities’ because a share is a piece of equity in a company).
What are ETFs?
These are essentially baskets of shares or assets combined, that can help you diversify any investments, and/or cost-effectively mimic an investment strategy or investment in an index. You can buy ETFs the same way you buy and sell shares. Moneysmart.gov.au. describes them as follows: “Exchange traded funds (ETFs) are a low-cost way to earn a return similar to an index or a commodity. They can also help to diversify your investments. You can buy and sell units in ETFs through a stockbroker, the same way you buy and sell shares.”
What about ‘Bonds’, ‘Commodities’ and ‘Derivatives’?
Bonds are tradeable debt (as opposed to equity) securities, usually issued by a government or semi-government bodyand corporationsto raise money. So,holders of the bond have essentially lent money for which they receive adefined rate of interest over a set period. The bond is repaid with interest on the predetermined maturity date. Most bonds can also be traded on the share market.
Commodities are the basic building blocks of the global economy: natural resources or agricultural products that are traded on dedicated exchanges throughout the world. For instance for Australia these are Iron Ore, Gold, Wheat, Copper, Coal etc.
The ASX describes Derivatives as follows: “Instrument that derives its value from an underlying instrument (such as shares, share price indices, fixed interest securities, commodities, currencies etc). They often involveleverage.” Now, the moment you hear ‘leverage’ your ears should prick up. For the inexperienced investor, this is where things can get really risky...This essentially involves borrowed money being used to invest. If the investment loses all its money, the debt has got to be paid back some other way. You get the drift!
Risky business: the difference between investing and trading
So,derivatives, including CFDs (contracts for difference), swaps and options, can representa much higher level of risk.You may also have heard of ‘day-trading’, which is the practice of buying and selling shares within a day in the hopes of making a quick profit thanks to the day’s price fluctuations. And ‘short selling’ where (usually professional) traders sell borrowed shares at a high price when they think the price is going to fall, and then buy them back at the lower priceto return to the lender, pocketing the difference. That is, of course, assuming the shares do what they were hoping they were going to do….but what if they don’t? Particularly considering they will have borrowed the shares at what turns out to be the lower price and must now buy it back at a higher priceto return to the lender. These activities don’t represent “investment” (which is about value investment management over the longer term) but “trading” which is essentially shorter–term activities aimed at beating the market to make a fast buck, and often borrowing funds to do so which is very high risk considering the potential losses.
Things to consider when trading shares
When you buy stocks there are things you should be aware of:
Shares can go up in value as well as down: remember this when investing
Beware borrowing to invest: be careful with leverage and products that involve leverage such as derivatives or leveraged ETFs
Understand the costs: make sure you know what it is costing you to invest and factor that in, including the tax that may be payable on any dividends or profit you make
Exchange rate risks: if you are buying stock in a different currency, remember that when you sell, the exchange rate could have a significant positive or negative impact on the value of that stock to you, regardless of how well it’s performed
Understand what you’re investing in: make sure you do some research before you invest